US embassy cable - 04PRETORIA4117

UNCLAS SECTION 01 OF 02 PRETORIA 004117 
 
SIPDIS 
 
STATE PLEASE PASS USGS 
 
E.O.   12958: N/A 
TAGS: EMIN, EINV, EIND, ECON, SF 
SUBJECT: South African Gold Industry in Crisis 
 
 
1. (U) Summary: The South African gold mining industry is in 
trouble.  End of June 2004 company results showed profits sharply 
down.  In response, companies have laid off workers, closed 
shafts, and recalculated ore reserves as they move operations to 
higher-grade ore.  Companies blame these problems on the strong 
rand, which since 2002 has strengthened faster than the dollar 
price of gold.  Since 1998, however, the average rand price of 
gold has actually increased by more than 50%, while the rand has 
weakened by 18%.  This suggests that the problem is not entirely 
due to the strong rand, and raises questions about management's 
ability to deal with a steady rise in costs.  End summary. 
 
Profits Down 
------------ 
2. (U) Annual and quarterly reports, to the end of June 2004, 
show severely eroded profits for the country's gold mining 
companies, with many reporting operating losses.  AngloGold, the 
country's largest gold mining company and second largest in the 
world, showed profit declines of 126% and 82% for the quarter and 
six-month periods, respectively.  Gold Fields, South Africa's 
second largest gold producer and the fourth largest producer in 
the world, recorded a 60% drop for the year.  Harmony Gold, South 
Africa's third largest gold producer, showed an $80 million loss 
for the year.  Durban Roodepoort Deep (DRD), the country's fourth 
largest producer, showed a net loss of $45 million for the June 
quarter.  These top four companies account for more than 90% of 
South Africa's gold production.  In August, the Chamber of Mines 
declared that more than 50% of the country's gold mines were 
operating at a loss, and that the industry had not experienced 
such hard times since the liberalization of gold in the 1970's. 
 
The Rand/Dollar Exchange Rate Compounds High Rand Costs 
--------------------------------------------- ---------- 
3. (U) Gold mining companies argue that the reason for their 
trouble is that they have been caught between strong rand costs 
and weak dollar prices.  They do have a point.  Compared with 
2002, South African gold companies earned 20% fewer rands per 
ounce of gold despite a dollar price of gold that has increased 
by 29%.  This is partly because the South African Reserve Bank 
inflation fighting policy has kept interest rates high, causing 
the rand to strengthen 38% against the dollar the past two years. 
The result is that, despite $400/oz prices, the rand price of 
gold has actually decreased 32% over the past two years. 
 
4. (U) The strong rand is certainly a major explanatory factor as 
to why times are so tough for the South African gold industry 
today.  However, there may be a page 2 to the story.  The fact is 
that in 2002 the rand was exceptionally weak, averaging R10.5 to 
the dollar.  Using 1998 as a base year, when the rand/dollar 
exchange rate was more stable, one finds that the average price 
per ounce of gold has actually increased by 36% in dollar terms 
and a hefty 48% in rand terms.  This has led some industry 
analysts to ask why are South African gold companies having such 
a hard time now when they were making money in 1998? 
 
5. (U) The answer is that costs are much less flexible today than 
they were in 1998, and company managers, buoyed by low rand costs 
and rising gold prices in 2002, may not have properly considered 
this fact when investing in marginal operations.  In 2002, when 
the rand was exceptionally weak and the rand gold price doubled 
to between R3200 and R3800 per ounce, managers aggressively took 
on higher cost projects on the assumption that the rand would 
stay weak, ignoring the fact that their rand costs had risen and 
would be harder to reduce if the rand strengthened.  When the 
rand did strengthen, mine managers had little choice but to begin 
closing down high cost and least profitable operations. 
 
6. (U) The fact is that costs per ounce were on the rise in South 
Africa when a weakened rand appeared on the scene to save the 
day.  Part of this is because most South African gold mines are 
now mature, i.e., the high-grade (and lower cost) ore has been 
mined and reserves are in decline.  Keeping these mature mines 
open means mining lower grade (and thus higher cost) ore.  New, 
high-grade ore reserves in South Africa are located deep 
underground and thus much more expensive to mine.  Deep and ultra 
deep mines require sophisticated cooling and transportation 
systems, specialized roof support, and extensive health and 
safety measures.  Moreover, mineworkers spend 2-3 hours of the 
workday simply getting to their underground locations. 
 
7. (U) Other costs in South Africa have also been rising.  Labor 
costs over the past decade increased by more than 8% per year 
while productivity increased by only 3%.  As many as 30% of 
mineworkers may be HIV positive, shortening job tenure and 
requiring additional training, medical, and pension costs. 
Spoornet, the state-owned railroad, raised general freight 
tariffs by 35% in 2003 and another 16.5% in 2004.  Rand Water, 
the state-owned water utility, raised tariffs by 18% in each of 
the last two years.  Eskom, the state owned electric utility, 
wanted desperately to raise electricity rates, but the government 
insisted on keeping any increase to below inflation.  Domestic 
steel prices escalated by about 40% along with U.S. Section 201 
safeguard action in 2002, benefiting former South African 
parastatal and still dominant steel producer Iscor. 
 
Triage 
------ 
8.  (U) The situation has left the gold mining industry reeling 
over government administered prices and the South African Reserve 
Bank's high interest rate policy.  Ever more vocal and combative, 
several large mining houses have been lobbying the government and 
unions for a change, but nothing has seemed to work.  Through 
petitions to the Competition Commission, several large gold 
mining companies unsuccessfully tried to force Iscor to lower its 
steel prices.  Finally, with quiet industry support, the 
mineworker's union marched on the South African Reserve Bank in 
August, protesting high interest rates and the strong rand.  The 
following day, the Reserve Bank lowered its repurchase rate 50 
basis points.  (The Reserve Bank denies a cause-effect 
relationship, but analysts are divided.)  The result was that the 
dollar value of the rand weakened about 5%.  In addition, unions 
have begun to soften their stance on bread and butter issues, 
such as working Sundays, every second Saturday, plus selected 
public holidays, which would add about 80 additional production 
days to the year and require a 12% increase in the work force. 
These changes have helped, but shaft closures and layoffs 
continue. 
 
Comment 
------- 
10. (U) Industry analysts project the rand to slowly weaken 
against the dollar (about 2-5% per year) and gold prices to trade 
in the $400 to $450 range in the medium term.  Under these 
relatively stable conditions, many marginal mines may stay open, 
but at lower production as closures of unprofitable shafts and 
working sections will still take place.  The larger mines will 
continue to produce at current levels, and new production, in 
particular from Placer-Dome's South Deep mine and Harmony's 
(previously Anglovaal) Target mine, could add about 32 tons net 
to annual output.  Notwithstanding, the Chamber of Mines 
estimates that total South African gold production will continue 
its slow decline in the long term, as it has since the 1970's, 
until stabilizing at 300 to 350 tons per year by about 2010.  In 
2003, South Africa produced 375 tons, 14.5% of world production. 
The Chamber believes that industry should mechanize its new mines 
and better train its work force.  [Established infrastructure in 
old mines does not allow for much mechanization.]  The result 
will be that the number of mineworkers will fall even further at 
a time when unemployment in South Africa is running at 42% (broad 
definition).  In the last ten years, the gold mining industry in 
South Africa has shed 125,000 jobs. 
 
FRAZER